10 Secrets of Filing Bankruptcy

If you are worried that you’re going to be left living in a cardboard box, please read below.  If you know what to expect, you can overcome many of life’s hurdles.

1. “Personal bankruptcy’s not just for the poor.”

Linda Frakes, an entrepreneur in Georgia, built a life around her six-figure income. But when her new business collided with the credit crunch, Frakes found herself facing a financial fate she’d never anticipated. “It’s a far way to fall,” she says. The biggest bankruptcies ever were the City of Detroit which filed for protection from creditors having a cash crunch lasting generation after generation.

Meet the new face of bankruptcy. This real estate market crash led the nation’s worst downturn in 70 years and pushed more formerly affluent people into bankruptcy than in previous recessions. Overall, personal bankruptcy filings were up 36.5% in the first half of 2009 from the same period the previous year, and experts predict the number of filings will keep rising even as the economy recovers.

Leslie Linfield, the executive director of the Institute for Financial Literacy, calls it “a middle-class recession”: Last year the institute surveyed likely bankruptcy filers and found that 8.1% made more than $60,000, up from 6.9% in 2007. Experts blame the increase on slumping real estate prices and job losses, which have cut deeply into professional positions. Claire Ann Resop, a bankruptcy attorney in Madison, Wis., sees a lot of mortgage brokers and real estate developers: “They made a lot of money, and now they can’t.”

2. “When it comes to bankruptcy, one size doesn’t fit all.”

No type of bankruptcy will eliminate certain kinds of obligations, like child support, alimony and most student loans. But there are differences in the way debt gets handled in personal bankruptcy, often depending on whether you file for Chapter 7 or Chapter 13. Each has pros and cons.

Chapter 13 Bankruptcy allows those with regular income to repay debts over three to five years.  Although this drags things out a bit, it does stop the foreclosure process in its tracks.  This means that anyone who is behind on his or her mortgage can keep the house and catch up on payments over time.  Those without reasons to file may file under Chapter 7 of the Bankruptcy Code.  Chapter 7 involves no payment plan leaving all eligible debt, such as credit card balances, wiped out.  The only caveat if one qualifies is if they own “big ticket” items must be able to shelter these with available exemptions or face loss of these assets.  Although it’s a free pass for some, those with assets such as expensive cars without a payment and houses owned free and clear may face liquidation and sale of these assets to the extent these assets cannot be sheltered by available exemptions.  The good thing is that there are amble exemptions available in law to shelter most things.

How do you know which form is right for you? Bankruptcy law is complex, and provisions vary from state to state, so it’s often best for potential filers to consult an attorney before deciding.

3. “We don’t want your house if we can’t get good money for it.”

A common belief about bankruptcy is that it will leave you with nothing, living out of a cardboard box, says Cathleen Moran, a bankruptcy lawyer in Mountain View, Calif. But that’s not necessarily true, even in Chapter 7 cases. In theory, Chapter 7 involves liquidating most of a debtor’s assets to pay creditors, including the home. But in reality, homeowners who end up filing often don’t have enough equity in their home to benefit creditors, either because they’ve taken out a second mortgage or the home’s value has fallen, or both. In such cases, the trustee handling the bankruptcy can decide not to liquidate the home, in which case the debtor gets to keep it.

Simply put, in a house that’s underwater there is nothing to attract a trustee who always gets a percentage of sale of non-exempt assets.  A trustee and the court will look at the available equity in a home calculated by the appraised value less liens and available homestead exemptions.  At present the available homestead exemption is equal to $23,675.00.  This means that your house must be valued $23,675.00 over all liens including taxes and water bills in order to be at threat of sale.  The homestead exemption, which in most circumstances allows you to keep your primary residence if your equity in it is below a certain threshold, can vary widely from state to state: from $30,000 for a married couple filing Chapter 7 in Illinois, for example, to $75,000 for the same in California.  In addition, although Chapter 7 tends to delay, rather than stop, foreclosure, you will be in a better position to work out problems due to improved debt/income ratios which most lenders rely on.   In other words, if all your debt has been extinquished all the money left over in your budget is available to pay a modified loan payment.

4. “Bankruptcy improves your credit scores down the road.”

Yes, bankruptcy will affect your credit scores.  Barry Paperno, the consumer-operations manager for FICO, the company that develops the credit scoring formula used by the three major credit bureaus, states that most credit scores are in the tank already by the time a person declares insolvency and have nowhere to go but up.   In addition, bankruptcy can be less damaging in the long run than juggling late payments on credit cards for years in a bid to postpone the inevitable. Bankruptcy stays on your credit report for 10 years, but improvement can begin repairing it immediately if you apply for a store or gas charge card and keep payments current as it is the activity on credit that gets reported to the credit bureaus.

In fact, most people have a history of lousy credit when they go bankrupt. However, they are able to return to (and maybe surpass) their pre-bankruptcy FICO score more quickly than the rare debtor with pristine credit who needs to file bankruptcy after, say, a serious illness — which could mean a credit score drop of 100 points or more, Paperno says. Since 35% of a person’s credit score is based on payment history, the further consumers get from any missed payments, the more their score improves, he says.

 5. “Debt settlement firms may do more harm than good.”

Debt settlement firms offer to play hardball with creditors and whittle outstanding balances by as much as 75%. They bill their services as an alternative to bankruptcy, but in many cases they can hurt more than they help. Debt settlement firms are unregulated, for-profit entities that require regular payments before taking any action on a consumer’s behalf. This business model works squarely against debtors’ interests, says Walter Benenati, a bankruptcy attorney in Orlando who worked briefly for a debt settlement firm. “They’re getting fees every month, so they have no incentive to settle (with creditors) as fast as possible,” he says.

In fact, you don’t need a middleman to negotiate with creditors. But, says Mariana Bekker, director of media relations for the United States Organizations for Bankruptcy Alternatives, a debt settlement trade organization, most debtors don’t have the “time, stamina or desire” to do it themselves. Either way, you’ll owe taxes on any amount saved on your debt.

On the other hand, debt erased as part of bankruptcy, by contrast, isn’t taxed.  To clarify, if you owe Discover Bank $40,000.00 and the debt settlement firm negotiates this down to $25,000.00, you pay the tax on the forgiven $15,000.00 because forgiven debt is considered taxable income, (That’s right: The IRS considers forgiven debt taxable income.)  However, the Federal Tax Code specifies that debt discharged in bankruptcy is never considered taxable income.

6. “Don’t settle with Mom first or forget to mention the condo in Boca.”

Many people naturally want to pay back their friends and family before filing for bankruptcy. This can be a big mistake for the reason that “any money repaid to “insiders” — including relatives, friends, acquaintances and business partners — within a year of bankruptcy is recoverable by the trustee. In additon, any payemnts to a creditor exceeding $600.00 within 90 days of filing is avoidable without questioning whether the creditor is an insider.  If the recipient doesn’t voluntarily return it, the trustee has the power to sue. A more serious infraction involves trying to hide assets from the court. So don’t even think about giving your Harley to your brother — or selling it for cheap — to protect it from creditors. Bankruptcy filers must list everything they’ve sold, transferred or given away over the past two years. And nothing can be transferred, given away or sold for less than market value.

In additon, trustees have the option of using the state fraudulent transfer laws and in Michigan the look back period is 6 years.  Although the cases where significant assets are transfered outright or for cut rate price are in the vast minority, the way the court forces compliance is by the weightyness of the penalty. The maximim penalty for Banruptcy Fraud is $25,000.00 plus 5 years in prison.

There are many ways bankruptcy fudgers get caught. Spurned lovers or creditors often turn them in.  Although many trustees and court would refrain from using such extreme penalties, they still have those arrows in their quiver and may use them in the case of an agregeous set of circumstances most of us would rather not discuss but leave it to your imagination, says bankruptcy attorney Kenneth Demers. He recalls a case in which the trustee read in the paper that a bankruptcy filer won big at the casio.  My firm gained sympathy for the debtor from the trustee and through negotiation, the trustee received the only amount won with no penalty or jail time.  The maximim penalty for Banruptcy Fraud is $25,000.00 plus 5 years in prison.

7. “You’d better save up before you file.”

Last spring, Angela Watson realized she was in over her head. The Web entrepreneur from Long Beach, Calif., had incurred more debt than expected launching her business and wanted to explore the possibility of bankruptcy.

Yet once she started pricing lawyers’ services, which averaged about $2,000, Watson realized she couldn’t afford to file Chapter 7. Lawyers suggested she borrow the money from family and friends. “I was so hurt by that,” says Watson, who hasn’t even told some of her loved ones about her situation. She’s hoping to file with the help of a legal-services nonprofit.

Lawyers in Chapter 7 cases generally request payment upfront; otherwise, their fees would be discharged during the bankruptcy process along with other debt. (In Chapter 13, lawyers’ fees become part of the payment plan.) The fees for Chapter 7 range from about $995.00 to $3,000, depending on the state and the complexity of the case. Bankruptcy court also charges routine filing fees of $335.00 to file Chapter 7 and $310.00  to file Chapter 13 bankrutpcy.

8. “Just because your bills stop coming doesn’t mean you shouldn’t pay them.”

Not only does filing for bankruptcy stop collection calls, but most bills stop coming as well. That’s because the courts immediately issue an injunction that prohibits collection actions against the debtor or his property. However, that doesn’t mean filers are suddenly released from payment obligations for secured possessions they want to keep — legal lingo for anything bought with collateral, like a car or house. During Chapter 7 proceedings, which usually last about four months, you must remember to pay for what you want to keep in the absence of a bill. (In Chapter 13, those bills are folded into the payment plan the court establishes.) Besides the house and car, secured possessions could also include an engagement ring or other jewelry.

Debtors must decide to “reaffirm” — that is, keep and stay current on — any secured debts before all other debts are eliminated in bankruptcy. To do that, in the absence of a bill, contact the party you send payment to. For example, those with Chase auto loans should call the company for logistical (not legal) guidance, says a Chase spokesperson.  Our office routinely complies with the law in contacting secured creditors notifying them of a filer’s intentions and securing reaffirmation, redemption or surrender.  Redemption in bankruptcy means only paying what the collateral is worth.  Of course a filer must secure the funds to pay through refinance and a court order allowing redemption.  Most offices will offer redemption of collateral for fees beginning from $750.00 to secure a court order permitting redemption.  In other words, say your car has depreciated to below $10,000.00 but the bank holds a balance of $18,500.00.  Through court permission, an order is granted establishing the collateral may be paid off at the lower price.  There are many companys who offer finance options to filers wishing a deal and we have a link on our website for once such lender the Automotive Fresh Start Center.

9. “Timing is everything.”

When you owe more than you own, it’s time to consult a lawyer, Linfield says. But that doesn’t mean bankruptcy is necessarily the next step, attorneys caution. It’s often best to wait until you think the worst is over, says David Leibowitz, a Chicago bankruptcy lawyer. If you file prematurely, you’ll likely incur more debt, which won’t be included in the bankruptcy discharge. For example, those facing hospitalization may want to postpone bankruptcy until that’s behind them. And for a Chapter 7 filer who stands to lose his home, holding off on filing can maximize the time living in the residence without making mortgage payments. To do this, wait until the eve of foreclosure to file for bankruptcy, Moran says.

On the other hand, there are situations in which it’s best not to wait. Those with no hope of repaying debt often have little to gain by putting off filing. In such cases, it’s usually better to bite the bullet sooner rather than later.

10. “Bankruptcy doesn’t have to be the end of the world.”

There’s nothing easy about bankruptcy. It can be especially hard for middle-class filers who face a swift and unexpected slide down the socioeconomic ladder. And those who file for medical reasons suffer the double burden of health problems and financial distress. An important part of the coping process, mental-health professionals say, involves acknowledging the normal feelings of depression, fear and anger that often accompany bankruptcy.

Many people emerge from Bankrutpcy stronger than they expected.  Bankruptcy has become a more widespread financial planning tool these days, lessening its stigma. “Misery loves company,” says Richard Shadick, a psychologist and the director of a counseling center at Pace University in New York City.

Before she filed, Frakes, the Georgia entrepreneur, dreaded the process and worried about how it would leave her. “I thought I’d be living in a double-wide,” she says. Instead, she parlayed her marketing skills into a deal on a new rental when she lost her home in Chapter 7. (She offered to market the subdivision in exchange for a lower rent.) She lost her old Chevy but got a bargain on a used Jaguar. More rewarding than these material comforts, Frakes says, was that she emerged from bankruptcy with her friends, her family and her faith intact. Indeed, support networks often make all the difference in helping people cope with bankruptcy, counselors say, so don’t be ashamed to reach out.